The global volatility continues, but so does a gradual recovery
A stunning Brexit referendum result, Australian election uncertainty and increased tension in the Middle East are the most recent drivers of volatility in our markets. Previous concerns about slower growth in China and a collapsing oil price are now less in focus.
Volatile markets make the investment experience much harder to bear, but if we take a step back and look through the noise we can see a slow but steady global economic recovery.
The rise of non-traditional drivers of volatility
The lead up to and the result of the British referendum held to decide whether the UK should exit (Brexit) from the European Union, typifies the increased role external events and factors are exerting on economies and markets.
In the past year we have witnessed some fundamental changes in Europe. The geopolitical structure of the Union is being tested on many fronts as discontent grows that membership of the EU is not delivering the benefits expected. A substantial rise in the popularity of nationalist parties across the region has been spurred by voters disillusioned with the lack of economic growth and opportunity, growing centralised control from Brussels and social dislocation caused by an influx of refugees from the war torn Middle East. The far from unanimous decision by UK voters to exit from the European Union is to date the most significant expression of this mood of discontent, which is likely to see other EU member states emboldened as they deal with their own national debates along similar lines.
This theme of popular discontent is also playing out on the other side of the Atlantic where Donald Trump, the Republican Party’s presumptive nominee for presidential candidate, has also been able to capitalise upon a similar mood among US citizens. He has managed to prevail thus far in what has been a very bruising and hard fought campaign without significant support from the Republican Party establishment.
As much as the world was surprised by the Brexit vote it is also surprised that Donald Trump has managed to navigate his way to being a candidate for the US presidency. Other examples of this sort of social and political polarity are occurring in the developed world with ever increasing frequency. On an arguably lesser scale is the very close outcome of our own Federal election. Both major parties have been troubled by the rise of the minor parties and their political diversity.
Are traditional factors ultimately to blame?
Generally political instability, social dislocation and the rise of non-traditional populist movements are closely linked to economic factors. Among the drivers of this in the current environment are employment and opportunity, wages growth, rapid expansion of technology replacing traditional roles, increasing longevity and the impact of an aging demographic on social security and healthcare funding. The discontent that is caused by changes in these factors is manifesting in society at an increasing rate which is creating larger scale uncertainty and in turn elevated volatility in financial markets.
Market valuations point to confidence in a continued recovery
Over the longer term, despite economic concerns, market valuations are near long term averages. This provides a degree of comfort that despite a more volatile environment, investors are prepared to look beyond the short term and allocate capital based on a more positive longer term outlook for markets. The level of unemployment, a key connective measure between the social and the economic situation, continues to improve. Chart 1 highlights the improvement in major economies of this measure since the GFC.
Chart 1: Unemployment Rate – Advanced Economies
To date, politicians, to a large degree, have been missing in action with respect to providing fiscal stimulus in an effort to create growth through public sector expenditure. It is likely we will see increased expenditure on major capital works programs as governments realise that monetary policy measures are becoming more extreme and having less of a desired impact as time progresses.
Global equity markets remain relatively resilient even though volatility is heightened due to the increasing influence of external events as highlighted above. This resilience indicates that investors remain generally positive about longer term prospects and that extreme levels of monetary policy easing are having the desired effect, albeit more slowly than anticipated. The US economy continues to improve at a modest rate, while China, having slowed, appears to have stabilised, and Europe despite its social, economic and political issues has managed to not slide into recession.
The low interest rate environment will continue to support market valuations
With interest rates now incredibly low and in some cases negative, share valuations and markets, despite their price volatility, are receiving support from historically low bond yields. While this period of low interest rates continues, it is reasonable to expect that cash and bond allocations in investment portfolios will likely be reduced to fund greater exposures to ‘risk’ assets such as equities, property and credit in search of higher returns, particularly income.
Some large pension funds in particular are struggling to adequately fund their future liabilities (member pension payments) as a result of the very low return from bonds. This may see them increase their exposure to risk assets as they seek to address this issue.
Australian economic growth continues
Currently, economic or GDP growth in Australia is running at a respectable 3.1% p.a., the second highest (behind Spain) in the developed world. Unemployment remains low relative to our peers at 5.7% p.a. and inflation is running at a meagre 1.3% p.a.
These are reasonable conditions for the Australian economy and while there are risks, it is not immediately evident what would cause a recession in the short term.
Longer term, as for most countries, growth is expected to remain challenging and we do anticipate some vulnerability particularly if the $A remains strong. In a post resources boom environment a weaker $A will be beneficial to our key exports from inbound tourism, education, hospitality, leisure and agriculture.
US economic growth also continues despite volatility
The US economy has been quite resilient this year.
Job figures posted recently were the highest in eight months. This has helped to ease concerns. The unemployment rate rose slightly to 4.9% from 4.7% but this was reported to be because more people had re-joined the workforce as job seekers’ confidence in their ability to secure a role rises.
Wages also rose slightly to bring the yearly gain to 2.5% which was pleasing for many economists as it demonstrates there is some pricing pressure returning to wages.
The figures suggest that the recovery in the US continues and the fall-out from Brexit will not affect the US economy to any great degree. Job figures suggest that US companies remain confident they can continue to hire workers with the aim of growing their businesses. The US consumption and housing sectors also continue a trend improvement.
On the consumption side, light vehicle sales are above trend and close to cyclical highs and housing starts in the US continue to pick up. While job figures move around from month to month, these data points ease fears of a near term recession and provide optimism that the US could withstand further rate rises without derailing the economic recovery.
Britain is trying to manage volatility to sustain economic growth
The Brexit result continues to cause elevated uncertainty. However, the British treasury and the Bank of England have undertaken measures to mitigate the impact. The UK treasury announced last week that corporate tax rates would be cut to 15%.
Economic growth rates will be affected by the Brexit result but the British pound, currently at 30 year lows, will benefit the UK’s exporters. A lower tax rate on corporate profits is also likely to encourage businesses and investors to keep more capital invested in the UK.
The situation remains fluid and further volatility is expected, the magnitude of the political fallout being an example. Politicians and policy makers are trying to limit the negative ramifications and judging by other global indicators, the effects have mostly been contained and economic growth should continue.
by Jeff Mitchell, Head of Investment Research, Australian Unity Personal Financial Services
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